Double, double, toil and trouble
One of the reasons George W. won re-election two weeks ago is that John Kerry was unable to convince the voting public — and especially the voting public in belleweather states like Ohio and Missouri — that the economy was as bad as purported. And one of the reasons he was unable to do so was the booming housing market in many parts of the US. If home prices are skyrocketing and interest rates are low, allowing you to refinance at 5.7% while boosting your mortgage-levereged consumption at the same time, who says times are hard?
The National Association of Realtors tells us today that in dozens of housing markets across the US, prices continue to soar into the stratosphere. That being said, incomes are not following in tow, Americans aren’t saving a damned thing, interest rates are finally beginning to rise and foreign capital is showing signs of losing interest in mortgage-backed securities. Is this bubble set to come to a bad end?
No housing markets are more bubbly than those in Florida and the Southwest. Over the past year, these are the bubbliest, tracking a rise of more than 30% in the median sales price on existing single-family homes. Following these numbers is the rise over the past three years.
| Metro area | 2003:III to 2004:III | 2001 to 2004:III |
| Las Vegas, NV | 53.7% | 89.9% |
| Bradenton, FL | 40.7% | 80.0% |
| Riverside/San Bernardino, CA | 36.2% | 98.9% |
| San Diego, CA | 32.5% | 93.7% |
| Sacramento, CA | 30.5% | 90.4% |
In these most frothy markets, “double, double” does indeed describe the process exactly. But what’s underlying these huge price gains? In short, what’s the fuel, and is it sustainable?
It certainly isn’t incomes. Using Freddie Mac median household income data, we find that at the national level the housing price-to-household income ratio is 4.5:1. In bubble-deflating London they’re finding a ratio of 5.5:1 is too high to support current prices. Quick calculations show ratios of 5.1:1 in Sacramento; 5.2:1 in Las Vegas; 5.7:1 in Riverside/San Bernardino; and 9.1:1 in San Diego.
Part of the story is an insuppressable enthusiasm for adjustable-rate mortgages and low downpayments. In Las Vegas the use of ARMs has shot up from 19% of all loans a year ago to 55% in 2004:III. In the Los Angeles/Long Beach/Riverside region, use of ARMs has gone from 27% to 58% of all loans. In Sacramento, the usage went from 28% in 2003:III to 67% today, and in San Diego, from 37% to an unbelievable 72%!
The incredible price gains have completely eliminated the marginal and first-time buyer from the market. Nationally, those buying with downpayments of less than 20% of the sales price — i.e. those putting down so little as to be forced into mortgage insurance — make up around 23% of the market now (a year ago they were 30% of the market). These folks have fallen to just 20% of the market in Las Vegas, 13% in Sacramento, 12% in Los Angeles and a paltry 5% in San Diego.
When first-time buyers were eliminated from the housing markets in Australia and the UK, prices began to slide. In the latest data from the National Association of Realtors, we may be seeing the bloom coming right off the rose in some US markets as well.
California is the place to look. From the second to the third quarters of this year, median home prices actually fell in both Orange County (for the first time since 2002:IV) and in the Bay Area (for the first time since 2003:I). In Orange County, prices changed -1.8% as the mortgage insurance crowd fell to under 13% of the market. In the Bay Area, prices changed -0.2% as the mortgage insurance crowd fell to a mere 8% of the market. In both places, effective interest rates are up around 0.25% over the last six months. The price-to-income ratio in the Bay Area is around 7:1, and in Orange Co. 8.7:1.
According to PMI Mortgage Insurance,
Of the country’s 50 biggest cities, homeowners in San Jose stand the greatest chance of seeing their homes plunge in value . . . San Jose, Oakland, and San Francisco are three of the top five MSAs at the top of the risk index list.
The housing bubble in California may finally be ending. We Americans are spending every dime we come across, so much so that our savings rate this year may be the lowest since the Great Depression. With all these adjustable-rate mortgages, housing costs are going to rise in the coming years. While nominal household incomes in some California markets are up a nice 6-7% over 2003, they’re stagnant (and thus in real terms, they’re falling) in other housing-bubble cities like San Jose, Las Vegas, Phoenix and Washington, DC.
As Nixon’s chief economist Herb Stein (father of Ben Stein) once said, €œIf something cannot go on forever, it will stop.€ These housing prices cannot go on forever, and when they stop, the consumption which they fuel will stop as well. Will there be anything to replace this asset bubble when that day comes?
November 15th, 2004 at 2:05 pm
One of my credit card ststements came today, it also advised me that the rate for credit would be raised in January.
November 15th, 2004 at 2:11 pm
There is nothing to replace the consumptin fueled by borrowing against your home. What is left to borrow against? And once the price of houses falls, the value of the loan is not really covered by the value of the house, and we have a nation of technically non-secured debtors filing for bankruptcy. No savings to speak of, pension plans going the way of the dodo, hiring at an all time low…it is disheartening, but reality bites.
November 15th, 2004 at 3:39 pm
While it may be broadly true that Americans have less in savings these days, I believe the savings rate statistic used by economists does not consider equity holdings (stocks, bonds, mutual funds, etc.) as “savings.” Since interest rates are so low these days, few people with surplus assets are likely to have them in traditional savings vehicles like banks or money market accounts. As assets move from the overvalued real-estate market back into equities and breathe life back into flacid portfolios, it is possible that the impact on household wealth may be a wash. That is, unless US investment starts going to foreign currencies as a store of value, at which point the average person is probably screwed.
November 15th, 2004 at 3:56 pm
Truly scary are the INTEREST ONLY loans - the buyer doesn’t even begin to pay principal for many, many years… I think actually the market has slowed a lot in SD - my neighbor’s house has been on the market for months. Now people are starting to buy again in fear of rising interest rates, but I think we’re real close to the market peak. We’ve remodeled our fairly small home rather than buying up like many of our friends have. I think we’ve probably made the right choice - our mortgage is about 1/4th the current value of the house. Sure, we could pull out equity, but why? We have cars pretty nearly paid off or financed with low-rate loans. We are comfortable, and don’t need to go bigger to feel better about ourselves. I would say our consumption is definitely leveling off, and I see others beginning to do the same.
I feel badly for first-time buyers here - there is no way to be able to afford a first-time house in the current SD market. Most first-time buyers are pushed out to Temecula and even their prices are way up. I suspect this bubble is really close to busting…
November 15th, 2004 at 5:59 pm
Real estate money piling out of the market before it turns? {Did/is this happening in the UK?} Rob thinks it might head back into the stock market but isn’t it more likely to relocate in real estate? These are pockets of over-valued real estate so my guess it that this money which has done well with what it knows in the past 3-4 years will stay with what they know.
As far as breathing life into flacid portfolios, it seems to me that the consumer who buys those products and services that propel those stocks is the real life/breath of the market. The housing market, esp in those hot spots, is taking the lion’s share of the spending, no?
Again, I like Kasriel at NorthernTrust here for many interesting and informative articles.
November 15th, 2004 at 10:31 pm
Do I read this right — people who put less than 20% down payment are less in high-price markets and declining? You must mean people putting more than 20%, right?
November 16th, 2004 at 5:40 am
What he is saying is, the statistics show that people with plenty of profit on selling a home are rebuying in the same markets, moving “up”. Ie: the more money you have to put down on a property usually means you have just sold your own previous home and have a slush fund to plonk down. First time buyers don’t have this.
This is a post WWII thing, first home buyers getting mortagages easily. The GI bill encouraged home buying, for example. Before WWII, to buy a house, you had to get at least 30% of the price in cash, often 60%. This greatly restricted the housing market.
Our housing market boomed for two reasons: the baby boomers moving up and their children getting in at the bottom much easier than the parents entered the market plus the WWII generation dying off quickly now, allowing the boomers to inherit the GI bill properties. This is a one time thing.
November 27th, 2004 at 4:00 pm
I wonder if part of the reason for the decline of people paying less than 20% down if for an even scarier reason than first-time buyers being priced out of the market.
I live in San Diego (a renter priced out of the market) and I see and hear a lot of ads for “hybrid” mortgages, where people get a conventional (well, if you see an interest-only adjustable-rate mortgage as conventional) 1st mortgage for 80% of the purchase price and a 2nd mortgage at a higher rate (also adjustable) for the remainder. My guess is that htis would show up in the statistics as a home with a loan-to-value ratio of 80% and under.
The realtors here are still largely parroting the line that, while prices might stabilize, there won’t be any big drop, because demand is so high. They don’t see the elasticity of demand. If interest rates rise by a percentage point, that would be a substantial increase in the monthly payment for the adjustable-rate loans and a huge percentage increase in the monthly payment for interest-only loans. Either San Diego will have to start paying much higher wages, or a math-distortion field will have to prevail over San Diego, or the unthinkable will have to happen and demand will fall and prices drop.
December 5th, 2004 at 2:03 pm
I see alot of landlords are starting to sell their properties in the D.C. area, even though their tenants are not moving out for many, many months. This is surely a sign of a top, if some landlords are scared to wait a few months to sell.